Many investors wonder why corporations split their shares and thus create more shares at lower prices. Why not keep the same number of old shares trading at whatever price the market puts on them?
Stocks are split for several good reasons, among them to make the stock price more appealing to buyers. Investors prefer owning as many shares as possible even if each one of them is lower priced. Most of us prefer to own 200 shares of a $20 stock rather than 100 shares of a $40 stock. Although the share price is lower, it still represents the same percentage of ownership.
Share prices of successful companies tend to grow consistently, and a high share price would discourage many investors who want to buy more than five or 10 shares but can't afford them at prevailing prices. Trading would tend to dry up, making it difficult to justify a listing of the shares on an exchange.
Splits tend to widen a company's ownership. A split is also a sign from management that business is going well and the company doesn't expect its share price to decline appreciably. Even better, splits are often accompanied by dividend increases.
One of the best examples of the advantages of stock splits is Baltimore's venerable McCormick & Co., headquartered now in Hunt Valley but for decades the source of those wonderful aromas that drifted across the waters of the Inner Harbor.
The spices and flavorings firm went public in 1915, 26 years after its modest beginning. Its products, first sold only in Baltimore, were spread in food stores along the East Coast until McCormick purchased West Coast-based Schilling in the 1940s and became a national business, notes James J. Harrison Jr., a vice president and the firm's chief financial officer.
In 1949, McCormick split its small number of shares -- something like 60,000 -- 4-for-1, with the share price going down accordingly.
Although most of McCormick's long-term shareholders bought after that initial split, they have much for which to cheer. Starting in 1962, McCormick has had seven 2-for-1 stock splits -- three in the 1960s, two more in the '70s, and others in 1988 and 1990.
Every share of McCormick before 1949 is now 512 shares. Therefore, someone owning, say, 10 shares bought for $250, would now have 5,120 shares. At the current price of just over $41, they would be worth more than $210,000.
But suppose McCormick shares had not been split and the original number of shares had simply gone up in price. If the share price and dividends had moved at the same pace as has occurred since the splits, it would take $21,000 to buy one McCormick share. That share, by the way, would pay more than $300 a year in dividends.
McCormick today is a worldwide food giant with annual sales likely to top $1.3 billion. Financially, it would be out of place if it had but 60,000 shares.
McCormick tends to split when its share price is above $40, and splits are often declared at the end of the year.
All split stories do not have happy endings. Jiffy Lube International, once an independent Baltimore company that is now controlled by Houston-based Pennzoil Co., provides a good example.
Jiffy Lube went public five years ago at $15, a hot issue. A company official called it the "McDonald's" of the quick-lube-and-oil-change business. The share price rose sharply on visions of quick expansion and big profits.
Jiffy directors split the shares 2-for-1 and even the split shares traded as much as $10 above the original share price of $15. The price had more than tripled. Soon, though, a strong trend of financial problems stemming from inadequately financed franchise holders led Jiffy's share price down the low road.
Jiffy's price was so depressed that directors split the shares again, this time a 10-for-1 reverse split. Each of those shares is now worth $5, computing to just $1 before the splits.